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Environment of Accounting
Accountingis the art of organizing, maintaining, recording, and analyzing financial activities. Accounting is generally known as the “language of business”. The accountant translates the accounting information into meaningful terms that are used by interested parties. Every organization – profit, nonprofit, charitable, religious, or governmental – requires the services of accountants in providing accounting information.
Accountants and the statements they generate are primary source of information on economic and business activity. Accounting information is used by everyone. The accountant keeps track of all business transactions. A business transactionis any business activity that affects what a business owns or owes as well as the ownership of that business. Most accounting information is stated in monetary terms and is designed to be useful in making economic decisions. These decisions are made both within and outside the firm.
The manager of an organization, who is charged with the responsibility of seeing that the enterprise is properly directed, relies upon accounting information provided to make appropriate decisions. The accounting information specifically prepared to aid managers is called managerial (management) accounting information.Managerial accounting information is used in three management functions: a) planning, b) implementation, c) control.
Planning. Planning is the process of deciding what actions should be taken in the future. A plan may be made for any segment of the organization or for the entire organization. An important form of planning is called budgeting. Budgeting is the process of planning the overall activity of the organization for a specified period of time, usually a year. A primary objective of budgeting is to coordinate the separate plans made for various segments of the organization so as to assure that these plans harmonize with one another. Planning involves making decisions. Accounting information is especially useful in the analysis step of the decision-making process.
Implementation. Making plans does not in itself ensure that the plans will be implemented. In the case of the annual budget, each manager must take actions to provide the human and other resources that will be needed to achieve the planned results. Each manager must also make more detailed implementation plans than are encompassed in the approved budget. Although much of this activity is routine, the manager also must react to unanticipated events, changing previous plans as necessary to adjust for the new conditions.
Control. It is the managers’ responsibility to see that the work is done, and done properly, by the employees of the organization. The process the managers use to assure that the employees perform properly is called control. Accounting information is used in the control process as a means of communication, motivation, attention-getting, and appraisal.
The decisions managers make can be classified into four major types: financing decisions, resource allocation decisions, production decisions and marketing decisions.
Managerial accounting provides the information for these decisions. In form, managerial accounting information may be general (for use in long-range planning) or detailed (for use in cost control). The uses of managerial accounting information are varied, ranging from decision making by managers charged with successful operations of the specific division to which the information relates to planning in both the long and short range.
For internal use by management, managerial accounting information generally is narrow in focus. It usually relates to a part of the company’s operation.
Financial accounting informationis intended both for managers and for the use of parties external to the organization, including shareholders (and trustees in nonprofit organizations), bankers and other creditors, government agencies, and the general public. Investors in an enterprise need information about the financial status and future prospects of an organization. Bankers and suppliers grant loans and extend credit to organizations based оn their financial soundness. Even customers and employees concerned about the condition of an organization make use of accounting information. The external users of accounting information and the types of questions for which they seek answers can be classified as:
Stockholders, prospective stockholders in a corporation, and their advisers - financial analysts and investment counselors. Should an ownership interest be acquired in this firm? Or, if one is now held, should it be increased, decreased, or retained at its present level? Has the firm earned satisfactory profits?
Creditors and lenders. Should a loan be granted to the firm? Will the firm be able to pay its debts as they become due?
Employees and their unions. Does the firm have an ability to pay increased wages? Is the firm financially able to provide permanent employment?
Customers. Is this firm offering desirable goods and services at reasonable prices? Will the firm survive to honor its product warranties?
Governmental units. Is a public utility earning a fair rate of return on its capital investments? Can a firm install costly pollution control equipment and remain profitable?
Besides keeping track of accounting information the accountant is also called upon to prepare various reports. There are three basic reports that the business organization uses on a regular basis: income statement, statement of capital and balance sheet.
Financial statements provide information on a firm’s financial condition (or position), on changes in this position, and on results of operations (profitability). All businesses maintain records based on an accounting period of 12 months that follows either the calendar year or any other complete 12-month period known as fiscal year. Many companies publish these statements in an annual report. This report also contains the auditor’s opinion as to the fairness of the financial statements. In addition the accountant may be called upon to prepare financial statements, known as interim reports, for a period of time less than a complete accounting period.
Financial accounting information generally relates to the firm as a whole, since outsiders can make decisions only on matters pertaining to the firm in its entirety, such as whether to extend credit to it. Such information, usually historical, is a report upon what has happened. Because interfirm comparisons are often made, the information supplied must conform to certain standards. In the USA there are Generally Accepted Accounting Principles (US GAAP). In most of the rest of the world there are International Financial Reporting Standards (IFRS). There is a basic similarity of GAAP throughout the world though in some respect they may differ from country to country.